Ukraine could be the test case that upsets Russia's gas monopoly

Dr. Iryna Lendel is the assistant director of the Center for Economic Development at Cleveland State University's Maxine Goodman Levin College of Urban Affairs

Last week Ukraine made headlines in the European press, setting a precedent in democracy and defiance while making a seminal decision for its energy sector.The second Production-Sharing Agreement with U.S.-based Chevron Corp. is on its way to the Cabinet of Ministers of Ukraine for final signatures after it was approved by two local councils in western Ukraine. Earlier this year, Shell Oil, in a consortium led by U.S.-based ExxonMobil and three smaller companies from Austria, Romania, and Ukraine, signed a $10 billion deal for shale exploration and production in eastern Ukraine. Chevron's investment could be of a similar size. Ukraine is a nation that, while currently dependent on imported natural gas, is estimated to have a large amount of shale gas. The country imports about 54% of the gas it now uses, but has 39 trillion cubic feet of proven natural gas reserves. Ukraine pays more than $11 per mcf for its gas — one of the highest prices in Europe. That translates annually to about $12 billion that Ukraine pays to the Russian energy company Gazprom. Ukraine, where the current annual GDP is about $165 billion, would need to invest about $207 billion in its energy sector by 2030 if it wants to become energy-independent. This is why the investment of Chevron is so critical for Ukraine and why Gazprom must be unhappy to allow a precedent in a country that is heavily dependent on gas imports and just starting to find its way to economic and political freedom. The deal with Chevron was set back in August when the Ivano-Frankivsk regional council rejected a draft of the Production-Sharing Agreement, based on a weak guarantee against damaging the environment. It was approved a month later after a promise by the central government to stream 10% of profits from production into the budget of the region.

Last week's approval by the Lviv regional council was expected to go through a similar ordeal. Approval passed with 66 votes, compared to the 60 needed, despite the fact that there was fierce opposition from one of the most popular parties in western Ukraine, “Svoboda” (Freedom). There are many interesting points to be learned from these events. On one hand, the numbers speak for themselves when there is a question about what is draining the Ukrainian budget. At the same time, the population pays a heavily subsidized price for utilities and there is a very slim chance the central government will stop subsidizing its population's use of energy without expecting massive protests. There are huge inefficiencies in the system, including old high-energy-consuming industrial technologies and an old pipeline system that passes gas from Russia to Europe and requires significant maintenance.Then, why, is the deal for investment in shale development opposed by those who should be storming for independence of Ukraine from Russia?Because the issue has become so political, people are left with very poor choices. They can support what is rumored to be a corrupt and unpopular central government, but one that is taking steps towards economic development and promoting shale exploration. Or, they can continue to pay high prices for gas and be accused of playing up to Russia, but eliminate some of their environmental concerns. There is a bright spot in the story. Ten, or even five, years ago it was unthinkable to deny the approval of a Production-Sharing Agreement to a central government that subsidizes about 50% of regional budgets in Western Ukraine. Moreover, the regulations are made with a loophole that allows the central government to approve the deal with Chevron even without an agreement of the regional councils. The current environment illustrates that Ukrainians have different genes now — genes of defiance and freedom that were imbedded at the time of the Orange Revolution. Now they need to acquire a gene for doing business and creating economic prosperity through energy security.

Why is it so hard for Ukraine to take a democratic path towards the independence of its economy and energy sector, towards transparency and away from corruption?Too much is at stake for Russia. This is the first former Soviet republic to strive for absolute independence. Even more intimidating for Russia, Ukraine has the resources to accomplish the mission. This is the country that despite years of economic decline is still making steel and shipping it to the United States. This is the country that invented continuous casting of steel and licensed it with full rights to Japan. It is growing wheat and at its best was producing 2,205 pounds (a metric ton) of wheat per capita, exporting it along with weapons, sugar, coal and electricity.The country needs to cut its inefficiencies — in politics, in the economy, and in energy. While, in western nations, agricultural production has a loss rate of only about 5%, farmers in Ukraine are only able to bring in about 50% of their potential production. Ukraine uses 4.5 times more energy for every dollar of its GDP than does the U.S., and 6.8 times more than Japan. And for the last decade, the country lost more than 6 million people to emigration and declining birth rates. The country could be a big test for Gazprom's control of politics in Europe and among countries that are former Soviet republics. Ukraine needs to help itself by becoming smarter and more focused. It also needs help from American investors like Chevron that are willing to take a risk and drill in the Ukrainian shale. It needs support and engagement from the Ukrainian diaspora in the U.S., who were effective for many years and could help erase the image of America as an exploiter coming to Ukraine to sack its natural resources and ruin the environment — an image that is convenient for Gazprom. That includes support from those of us in Ohio, whose example of Utica development was mentioned many times during the last week in Ukraine as a state that is setting the standard in responsible development while preserving its environment.Ukraine has a long way to go, but it is being watched by all of Europe to see it set the precedent of making an energy-independent choice.

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